BofA Hartnett: Everything has reached “liquidity peak,” the Fed will be forced to “capitulate,” and Bitcoin is the first to sniff out rescue signals.
Recently, there has been a significant divergence in the market's outlook regarding the Federal Reserve's rate path for December. Previously, due to mild inflation and weak labor data, the market widely believed another rate cut in December was almost certain; however, a series of recent hawkish statements from the Fed have poured cold water on this optimistic expectation. Although some officials signaled dovish views on Friday, the debate over monetary policy direction toward the end of the year remains unresolved.
Michael Hartnett, Chief Investment Strategist at Bank of America, stated in the latest Flow Show report that based on the shock that current tightening liquidity has caused to multiple asset classes, the Federal Reserve is under pressure to continue cutting rates, and the crypto market may be the first indicator to sense a central bank policy shift.
Hartnett pointed out that assets such as cryptocurrencies, credit, the US dollar, and private equity have shown “liquidity peak” signals. In the past two years, repeated rate cuts by global central banks have stoked speculative sentiment, but the Fed’s recent hawkish comments have raised doubts about further easing policies in 2026. Cryptocurrencies have taken a heavy hit, with Bitcoin and Ethereum continuing to fall, highlighting the impact of tightening liquidity on risk assets.
Hartnett anticipates that the current weakness in US bank stocks is releasing signals similar to those in December 2018, and the continued decline in liquidity-sensitive sectors may force the Fed to shift toward easing. Looking back at 2025, global central banks have collectively cut rates 316 times, which sparked a liquidity feast, directly fueling three major market phenomena: the frenzy in AI investments, dramatic swings in Japanese stocks, and speculative surges in cryptocurrencies.
Looking ahead to 2026, Hartnett predicts that the Fed will once again “surrender” on policy and be compelled to start a rate-cutting cycle. In this scenario, three asset classes will benefit most: first, long-term zero coupon bonds, whose duration advantage will directly deliver a valuation premium as rates fall; second, Bitcoin, which, as the asset most keenly sensitive to liquidity, has historically rallied even before rescue signals fully materialize; third, mid-cap stocks, as these companies are most sensitive to financing costs and will show significant earnings elasticity and catch-up potential once rate cuts are realized.
Japan's Debt Crisis Intensifies Global Liquidity Concerns
Japan is now facing a simultaneous crash in its bonds and yen. Over the past two weeks, 30-year government bonds have dropped 5%, and the total decline for the year has reached 12%, the worst performance since the 1970s. The yen/dollar exchange rate is approaching 160, hitting a 40-year low.
Meanwhile, there is clear policy misalignment. The new Japanese prime minister has launched a massive fiscal stimulus equal to 3% of GDP, while the Bank of Japan’s effective policy interest rate remains at minus 2%. This combination of “loose fiscal + easy monetary” policies has intensified the pressure on the yen and government bonds.
Japanese government bond yields have now broken through key resistance, in stark contrast with the global bond market's recovery. Policymakers are caught in a dilemma: raising rates to contain inflation could trigger a stock market crash, while maintaining easy policy will keep pressure on the currency and government bonds. This crisis is spreading globally through a chain of carry trade unwinding, and rising Japanese yields may lead to international capital repatriation, impacting dollar liquidity and, in turn, US stocks, credit bonds, and crypto markets.
Liquidity Tightening Signals Emerging Across Multiple Markets, Fed Policy Shift Imminent
US mid-cap stocks are currently showing a clear divergence between valuation and performance. While valuations are at a low 15x and benefitting from easing trade tensions and manufacturing reshoring, their performance this year remains under pressure. This contradictory phenomenon underscores how the Fed’s policy adjustments have significantly lagged behind actual market needs.
The bank stock index has fallen below 140, and the broker index below 950—two sectors that are highly sensitive to liquidity and have always been leading indicators for policy shifts. As seen in the 2018 December market episode, they will be the first to react to potential liquidity easing.
Hartnett believes the signals for the Fed to continue cutting rates have already appeared. Over the past two years, global central banks have collectively cut rates 316 times, fueling “group exuberance” in the market, and investors widely anticipate more rate cuts in 2026, though recent hawkish Fed statements have triggered some concern.
At the same time, Hartnett stresses that if the Fed is forced into sharp rate cuts, the market will see a large number of investment opportunities. Historical experience shows that central banks' policy “surrenders” have often brought significant revaluation opportunities to risk assets.
Cryptocurrency Becomes a Policy Turn Indicator
Hartnett believes that Bitcoin and other digital assets will act as the “canary in the coal mine,” providing investors with important policy warning signals through their price movements. This judgment is based on the crypto market's high sensitivity and rapid reaction to liquidity changes.
Despite recently suffering sharp declines, with both Bitcoin and Ethereum plummeting, Hartnett believes cryptocurrencies will be first to sniff out rescue actions from the Federal Reserve. According to Bank of America's November fund manager survey, crypto assets only account for 0.4% of institutional allocations, but in 2025, retail funds flowing into the crypto market reached a record $46 billion. Derivatives trading currently accounts for 74% of crypto trading volume, making it the forefront of liquidity and speculation.
Institutional allocations to crypto remain limited, yet the massive inflows of retail funds reflect strong market expectations for eased liquidity. Once the Fed signals a policy shift, the crypto market may be the first to rebound.
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